Japan, Fiscal Policy & Lost Lessons
This week’s Economist has an interesting article looking at the lessons from Japan’s lost decade which, although focussed on the Eurozone, has important lessons for the UK.
As I’ve noted previously, on the current IMF growth forecasts the UK is already set for Japanese-style lost decade.
Having run through the similarities between the Japanese situation in the early 1990s and the aftermath of the 2008 crash the article draws out some lessons – one of which is the importance of fiscal stimulus to kick start recovery. A lesson that appears not to have been learned:
In Britain and America there are two main concerns. First, the fiscal stimulus may not be bold enough and in Britain is being withdrawn before the economy is back on its feet. Having supported banks, governments are trying to cut deficits and have little to spend. Richard Koo of Nomura, a bank, reckons Japan’s experience shows that governments should increase borrowing to mop up private-sector savings.
Of course, the counter argument to this would be that this would increase the debt burden, but as the Economist notes:
… in a growing economy, high debt need not be a problem. Take a household’s finances. A large mortgage is fine as long as breadwinners’ incomes are sufficient to pay the interest and leave some to spare. Inflation helps too, as debts are fixed at their historical values but wages should rise with inflation.
One problem with the UK fiscal debate over the past two years has been the lack of quantification – the government’s opponents have argued that austerity is counterproductive but often been unable (in purely macroeconomic, rather than social, terms) to say how counterproductive.
Thankfully an important study was published last week by NIESR. It modelled the likely effects of a delay in fiscal consolidation- i.e. rather than the government trying to deal with the structural deficit during a time of weak demand, what if consolidation had been delayed until the economy was performing better?
…our estimates indicate that the impact would have been much less, and less long-lasting, if consolidation had been delayed until more normal times. The cumulative loss of output over the period 2011-21 totals about £239bn in 2010 prices, or 16 per cent of 2010 GDP. And unemployment is higher for some two to four years longer if tightening comes when the economy is depressed. So early tightening has real, large costs.
The NIESR study finds that the exact same package of spending cuts and tax rises as unveiled in 2010, if timed to start in 2014 rather than in 2011 have led to a very different outcome.
The important point to grasp here is that NIESR did not test for a macroeconomic stimulus, as supported by the TUC and a growing list of others, merely a delay in the cuts and tax rises.
Under the alternative scenario, GDP is a cumulative 16% higher over the decade (to get populist about this – that’s just shy of £4,000 per person that early austerity is costing everyone in the UK over a decade) and unemployment, rather than being stuck above 7% until 2016, would been below 7% for most of the decade.
The key to understanding how simply delaying the austerity programme by three years would have such a large impact is to recognise, as NIESR do, that fiscal multipliers are not constant. During a time of weak demand, already low interest rates, global turbulence and banking problems then the impact of austerity is far greater than it otherwise would be.
I believe it would be fair to take this a step further and argue that a stimulus, under present conditions, would be even more effective to.
Of course under a delayed consolidation (and it’s worth emphasising once again, this is delayed consolidation – not stimulus) debt levels would have been somewhat higher under NIESR’s model. But only somewhat, the impact of higher growth and lower employment counteracts the effects of cutting less.
In the graph below the black line is what happens under the government’s current plans and the red line is modelled impact of a three delay in austerity.
By 2021 the Government should have achieved a debt/GDP ratio in the low 80s, under the alternative it would be closer to 90%. The question has to be – is reducing debt/GDP by under ten percentage points really a price worth paying for much higher unemployment and much lower growth? I think not.
Back in 1925 Winston Churchill noted that there policy makers who were “perfectly happy with the spectacle of Britain possessing the finest credit in the world simultaneously with a million and a quarter unemployed”. We seem to be making the very same mistakes.